Are Machines Catching Up with Human Advisors?

The rise of machines in wealth management has in large part been unable to replicate a key advantage that human portfolio managers claim to hold – “tax location” sensitivity.

In a process also known as “asset location,” brick-and-mortar advisors use their intelligence and communication skills to apply proper due diligence in divvying up investments in tax-savvy ways across accounts. By some estimates such a top-down review can improve client returns by as much as 0.5% a year.

But while most robo advisors only allocate assets one account at a time, industry observers say others are tweaking their offerings to be more all-encompassing.

“A select group of robos are becoming more sophisticated in their asset-location strategies,” says Sean McDermott, an analyst with Corporate Insight in New York.

This, he adds, “could strike at the heart of how human advisors create comprehensive investment plans for clients.”

But McDermott figures “robos are still facing an uphill battle to win over the type of high net worth investors who’ve got multiple accounts and more sophisticated tax situations.”

Robos leading the charge into asset location algorithms don’t necessarily disagree that many of America’s richest families will continue to favor human FAs.

But these robo innovators tell FA-IQ they see plenty of opportunities to use cutting-edge advances – particularly in high-touch areas like asset location – to significantly help attract more retirees and veteran C-suite executives.

Wealthfront, an early developer of tax-sensitive robo services, says its platform now delivers “a true mean-variance optimization” process. This involves scanning asset classes through both short- and long-term investment periods to find the best funds for different types of accounts, according to the Redwood City, Calif.-based firm.

“I know of very few traditional advisors who provide the level of sophistication in asset location that we offer,” says Adam Nash, chief executive at Wealthfront, which manages more than $3.5 billion.

The robo’s programs sort out in taxable accounts “the actual net-of-fee, after tax return of the exact financial products we use,” he says.

In tax-deferred accounts, before-tax returns are a prime input used by the firm’s computers to generate portfolios.

Together, Nash estimates these “smart” asset location functions – which are built into Wealthfront’s back-end and thereby transparent to investors – can increase a client’s net returns by thousands of dollars a year.

For instance, over 20 years Nash figures such adjustments could generate another $28,000 to someone making an initial investment of $100,000.

Adds Nash: “As our CIO (Burton Malkiel)always says, ‘You cannot control the markets, what you can do is to keep fees low, stay diversified and be smart about taxes.’”

At Personal Capital, a hybrid robo that manages $2.4 billion, tax location is also delivered in real time.

Mark Goines

This “gives us a much bigger opportunity to appeal to a broader cross-segment” of the wealth management marketplace, says Mark Goines, the robo’s marketing chief.

Stepping back, his own survey of top competitors in the field seems to support such an assertion. A typical rival robo works with 1.2 accounts per client, estimates Goines. By contrast, he finds that Personal Capital manages an average of 2.6 accounts.

“Unlike most robos, we don’t manage client assets one account at a time,” says Goines. “We look across someone’s whole portfolio and take a more complete view of a household’s total wealth picture.”

Even with advanced programming to give investors a more holistic and tax-sensitive process, Personal Capital finds a need to offer clients access to human advisors by phone or online.

So does fund giant Vanguard, which now manages more than $36 billion through its Personal Advisor Services unit. Its robo programming also has built-in asset location analysis, says senior PAS advisor Julie Virta.

Still, the online investment platform offers a pool of some 350 FAs to clients to help tailor their plans either by phone or teleconferencing.

“Asset location is helping to set our online platform apart and is critical to helping our clients reach their long-term goals,” says Virta. “But we still see investment planning as nuanced enough to require some sort of human intervention.”